Market Wrap, Wednesday, 07/30/2008

Yo-Yo Market

by Keene H. Little

If you don't like the direction of the market today just wait a day or two
and it'll go the other way. If you like trading the market both ways and can
time the turns well you have to like this volatile market. But I suspect quite a
few are getting whipped pretty severely. And each time one side starts to think
they're winning they get a quick reversal to remind them to take their profits
quickly or else risk giving them back.

The bullish thing we've got going is the fact that the S&P 500 is back above the
January /March lows, the Russell 2000 (small caps) successfully tested the lows
and the Nasdaq hasn't even dropped down to those lows. The bearish thing is
we've got intermarket divergence with the DOW having broken below its
January/March lows and is currently finding them to be resistance. And of course
they're all still within a downtrend from last year's highs.

So we've got a real battle going on right now between the bulls and the bears,
each arguing their case every day in the market. Sometimes the bulls are winning
and the shorts run for cover. Other days the bears are winning and the longs are
getting spooked out of their positions. Once the weak holders (those trading
more short term or less sure about the future direction of the market) are
flushed out of their positions the market spins around and charges off in the
other direction.
Welcome to trading in a bear market.

The bulls point to the 2-day rally this week as proof that last week's pullback
was just a correction of the rally off the July lows and that we'll head much
higher into the election. But today's rally already showed signs of weakening in
some market breadth measurements as compared to Tuesday's rally. It doesn't mean
we'll see an immediate reversal tomorrow (although as I'll point out on the
charts, that's a possibility) but it does mean that we have some internal
measures that support
the idea that the bounce off the July 15th low is probably
a correction of the May-July decline and nothing more. How high the bounce will
get is the bigger question. As always I'll provide some upside targets and key
levels to watch as we wait for better clarity as to who's winning the tug of war
in this market.

The day started off quietly as far as economic reports go. The ADP jobs report
showed private-sector employment grew by 9,000 jobs. That's a small number but
at least it wasn't negative and certainly a lot better than the expected loss of
60,000 jobs. Add in 20,000 government jobs and we've got a heads up for the
payrolls number coming out on Friday. But the ADP report has tended to overstate
job growth in recent months as compared to government data and they did revise
their June
number to a 77K loss.

Helping today's mood was probably a report out that the SEC (Securities and
Exchange Commission) has extended the order protecting their favorite big
investment banks and Fannie Mae and Freddie Mac from the big bad bears who like
to short naked. The original order protected these banks until July 31st and now
the order has been extended to August 12th. I suspect it will be extended for a
lot longer than that. The only surprise was that they didn't add more banks to
their endangered
species list in order to prevent the bears from shorting them
too. I guess it pays to have contacts in high places in government in order to
get your name on that list. With the plethora of vehicles available to short the
banks' stocks (futures and options for example), it might not have as much of an
impact on trader activity as the SEC and others hope but I'm sure the order has
a psychological effect on the market--traders feel the government is here to
save them, again. We want all
gain and no risk. Seems to be the American way
now.

Crude inventories fell less than expected and that may have contributed to the
rise in crude prices today, up nearly +$4.60 from yesterday's close. The pundits
ignored the oil rise since the stock market rallied anyway. But it surely would
have been the cause of a stock market selloff had one occurred today. The US
dollar closed up slightly so that wasn't much of a factor in today's rise in
oil. I think oil is just ready for a bounce to correct the $27 drop from its
July 11th high.

And with that let's get to this week's charts.

S&P 500, SPX, Weekly chart

Last week's weekly candle was a doji which basically means indecision (it can be
a heads up for a reversal pattern if it's at support or resistance). I show
either a continuation lower in a steep selloff (dark red) or a little higher
first before selling off (pink). The bullish things I see are oscillators
turning back up and MACD is showing a bullish divergence against the new price
low in July vs. the January/March lows. There is potential for SPX to rally back
up to its downtrend
line from October 2007, currently near 1400. I think there
are lots of reasons we will not see that kind of rally but that's the potential.

S&P 500, SPX, Daily chart

After the May-July decline we've been in a bounce to correct it. A typical
retracement is around 50% and the first leg up to the high on July 23rd achieved
only a 38% retracement. While that could certainly be all we'll see, the
correction is short in both time and price when looking for a more typical
correction. Therefore a larger 3-wave bounce up to perhaps the 1320 level (50%)
would be more likely and is shown in pink. It's possible that today's bounce
completed the correction
of the move down from July 23rd which would mean some
hard selling is next, shown in dark red. But this scenario requires a
near-immediate selloff tomorrow. Any higher than the July 23rd high at 1291
would suggest we'll see the higher rally into next week.

We will show you how you can make $2,000 in cash each month using your existing portfolio equity as collateral. This low-risk strategy works no matter which direction the market goes. Best of all, it is easy to implement and no previous experience with options is necessary.

The 60-min chart shows the proximity of the downtrend line from May 19th to the
July 23rd high at 1291. If the market heads higher tomorrow morning I'd watch
for resistance at that level and a deeper pullback before heading higher into
next week (pink). But if the bears get a hold of the reins tomorrow and start
driving the market lower again, it will be possible the correction is over and
we'll start heading lower at a higher rate of speed. A break below 1235 at any
time now would
be very bearish.

Dow Industrials, INDU, Daily chart

The DOW's daily chart looks very similar to SPX. The horizontal red lines show
the levels of resistance. The July 23rd closing high was right at the January
low and therefore that's recognized resistance now. If the bulls can push it up
through there and then the 11700-11750 area they'll have a shot at 50%
retracement near 12K. If the bears take over and drive the DOW back below 11125
then the selling should kick in hard.

Again, similar to SPX, it looks like we could be set up for a brief new high
tomorrow followed by a pullback. Whether the pullback develops into something
more serious (dark red) or just a correction before heading higher again (pink)
is the question. We might not even get the pullback shown in pink if the bulls
get very strong and the bears run for cover en masse. But with signs of waning
upside momentum I think we're probably close to at least the pullback.

Nasdaq-100, NDX, Daily chart

NDX has remained inside a consolidation pattern. It's either an ascending
triangle (flat top, rising bottom) or a flag pattern. Either is bearish as it's
a continuation pattern in the decline from June. As noted on the chart, keep an
eye on MACD and RSI for clues. If MACD gets above zero and RSI above 50 we'll
probably see NDX move up to the top of its flag, currently near 1900 (seen more
clearly in the 60-min chart below).

Inside a triangle will normally be five waves, labeled a-b-c-d-e as I've done on
the chart. This morning's high may have completed the pattern in which case we
should see strong selling begin (dark red). A rally above today's high of 1862
would suggest a move up to 1900 before potentially reversing back down and
heading to new lows.

Russell-2000, RUT, Daily chart

The RUT has been stronger in the bounce off the July low and still maintains the
possibility for a continuation higher. In fact it has the best chance of
exceeding the June high (if it does I think it will be the only one and only
marginally), shown in pink. But like the others, any continuation lower,
especially with a break of Monday's low near 694 would be a heads up that the
bounce is over and down we go (dark red).

After being rejected last week at the top of a parallel down-channel, BIX is
back up for another try. It would obviously be bullish if it can break above it,
in which case I see upside potential to the 240 area (apex of the previous
triangle pattern). But in addition to the top of the channel BIX is bumping into
its 50-dma. Not far above it is the 100-dma just under 218 and then the 200-dma
is heading down to where it might meet price around 240 by mid August. A drop
back below Monday's
low would say the bears win again and we'll see new lows
(dark red).

U.S. Home Construction Index, DJUSHB, Daily chart

The home builders index is cycling around the level of the 2002 lows, near 280.
Today it tagged its 50-dma again but got soundly rejected by it. A rally above
it at 287.63 would suggest we'll see a test of its downtrend line from February
2007, which is where the May rally failed. I continue to believe this index is
close to being finished to the downside. I've had the downside target of 216 on
my chart for well over a year now. I think the chances of it getting tagged are
still good
but trying the short the home builders is probably not your best use
of resources or time. I continue to watch it at this point mainly to see where
it will end.

Transportation Index, TRAN, Daily chart

The Transports banged into the broken uptrend line from January again and got
rejected again. It left a long-legged doji at resistance and if we see a red
candle tomorrow it will complete an evening star candlestick reversal pattern in
which case I would expect to see some strong selling kick in. But if the broader
market is able to rally higher into next week it will be important to see the
Trannies join in and get themselves back above that uptrend line.

U.S. Dollar, DXY, Daily chart

The move up from the July low looks like an impulsive 5-wave move (hard to see
on this chart) and that suggests we've got higher to go for the dollar's bounce.
But first it should pull back to correct the leg up to today's high. A pullback
to around 72.50 could set up the next rally leg (pink).

If the US dollar is rallying then commodities must be selling off. Well, some
did but not oil:

Oil Fund, USO, Daily chart

Oil got a nice bounce today, giving us the biggest white candle we've seen since
early June. With the increasing number of speculators shorting oil it's not
going to be hard to get some short-covering rallies going. But I believe we'll
only see a correction of the decline from the July high, perhaps back up to the
50-dma near 108, before heading lower again. I'm speculating on what the decline
might look like and just one idea is shown on the chart. However it gets there I
think the
downside target of $70-$80 remains a good one by September.

Oil Index, OIX, Daily chart

Oil stocks got a big bounce today with both the stock market and oil. Get two
tail winds behind you and you can do some serious sailing. OIX closed marginally
back above its broken uptrend line from March 2003 so obviously the bulls need
to hold it above. While the bounce could be over after today's rally I think the
larger price pattern would look better with a pullback and then another leg up
into mid August, perhaps getting as high as 900 before tipping back over into
the fall.

Gold Fund, GLD, Daily chart

As I had mentioned for the US dollar and its impulsive 5-wave move up from the
July low, gold has done the opposite. It's a little easier to see on its chart
the 5-wave move down from 97.50. Once a 5-wave move completes it's due a
correction and I think that's what started off this morning's low, which came
close to the 200-dma (slightly exceeded it on the gold futures contract). A
5-wave move does not stand alone so it should be followed by another one after a
bounce finishes, shown
in dark red. After the correction, labeled wave 2 on the
chart, we'll either see gold break for new lows (78-80 initial downside target)
or find support at its uptrend line from May (which could be the bottom of a
larger sideways triangle that will play out into the end of the year). I should
have a better idea which scenario could play out once we see the 2nd leg down
into the end of August (assuming it will play out as depicted).

Economic reports, summary and Key Trading Levels

Tomorrow's reports include GDP and Chicago PMI, either of which could influence
tomorrow's opening. Both are looking for a slight improvement over last
quarter/month so any disappointment could affect the market negatively.

Tomorrow is month end and the last two days have been bullish. A little painting
of the tape perhaps? Let's not scare the sheeple into calling for withdrawals.
Consumer sentiment is already bad enough and I'm sure more than one person (or
government entity) would like to see July finish on a positive note. Getting the
DOW back above the March low would be a good accomplishment.

The first few days of a new month are generally positive but only if there's new
money coming in for investments. If withdrawals are ticking higher then of
course the beginning of the month might not be so bullish. There is of course a
lot of money that comes in for regular 401(k) deposits and such but it's
interesting to note that there's been an increase in hardship withdrawals. As
many of you with 401(k) accounts probably know, you can borrow from your
retirement account for something
like a down payment on a house (and pay it back
into your account with interest which means you're paying yourself the interest)
or you can withdraw from it if you demonstrate it's for a hardship. Medical
costs would be one reason.

The increase in withdrawals from retirement accounts is proof that the American
consumer is cash strapped and now robbing the last piggy bank he/she has. Credit
card balances are increasing (as well as default rates) and consumers are going
after their last pot of money to pay off bills. It's scary really.

If you're playing the market on the long side I urge caution and tight stops.
Surprises will likely still be to the downside and the price pattern is setting
up where we can probably expect a very ugly open in the not too distant future
with hard selling to follow (think mini crash). We have some systemic problems
in our financial markets and the best the Fed and others have been able to do is
stem the bleeding. There have been massive infusions of whole blood (cash) but
the bleeding
continues. The patient may look somewhat OK on the outside but
inside there's a lot of damage inside. Don't let your account (bank, mutual
fund, retirement account, etc.) die with the patient.

Fundamentally the market remains overvalued, somewhere in the neighborhood of a
P/E of 18. Never has there been a bull market that started with a P/E that high.
To think we're starting another bull market after this year's lows is to
completely ignore history and say it'll be different this time. That's not how I
bet my money and I can only suggest you be in protection mode rather than profit
mode.

If we get a continuation of the rally into next week use it to lighten your
investment positions. Cash is good (even if boring). If you're looking for a
shorting opportunity use a break of Monday's lows as a sign we're heading back
down again. If we rally some more, watch the Fib retracement levels for possible
resistance next week and hopefully we'll have some good setups by the time I'm
back with you next Thursday. Good luck with your trading and I'll be back with
you next week and
every day on the Market Monitor where we'll try to catch these
swings.